Received 21 February 1996; received in revised form 24 February 1997; accepted 20 May 1997
Abstract
We test the effect of foreign direct investment (FDI) on economic growth in a
cross-country regression framework, utilizing data on FDI flows from industrial countries to
69 developing countries over the last two decades. Our results suggest that FDI is an
important vehicle for the transfer of technology, contributing relatively more to growth than
domestic investment. However, the higher productivity of FDI holds only when the host
country has a minimum threshold stock of human capital. Thus, FDI contributes to
economic growth only when a sufficient absorptive capability of the advanced technologies
is available in the host economy. 1998 Elsevier Science B.V.
Keywords: Foreign direct investment; Economic growth; Cross-country regression framework; Developing countries
116
1. Introduction
Technology diffusion plays a central role in the process of economic
development.2 In contrast to the traditional growth framework, where technological
change was left as an unexplained residual, the recent growth literature has
highlighted the dependence of growth rates on the state of domestic technology
relative to that of the rest of the world. Thus, growth rates in developing countries
are, in part, explained by a catch-up process in the level of technology. In a
typical model of technology diffusion, the rate of economic growth of a backward
country depends on the extent of adoption and implementation of new technologies that are already in use in leading countries.
Technology diffusion can take place through a variety of channels that involve
the transmission of ideas and new technologies. Imports of high-technology
products, adoption of foreign technology and acquisition of human capital through
various means are certainly important conduits for the international diffusion of
technology.3 Besides these channels, foreign direct investment by multinational
corporations (MNCs) is considered to be a major channel for the access to
advanced technologies by developing countries. MNCs are among the most
technologically advanced firms, accounting for a substantial part of the worlds
research and development (R and D) investment. Some recent work on economic
growth has highlighted the role of foreign direct investment in the technological
progress of developing countries. Findlay (1978) postulates that foreign direct
investment increases the rate of technical progress in the host country through a
contagion effect from the more advanced technology, management practices, etc.
used by the foreign firms. Wang (1990) incorporates this idea into a model more in
line with the neoclassical growth framework, by assuming that the increase in
knowledge applied to production is determined as a function of foreign direct
investment (FDI).
The purpose of this paper is to examine empirically the role of FDI in the
process of technology diffusion and economic growth in developing countries. We
motivate the empirical work by a model of endogenous growth, in which the rate
of technological progress is the main determinant of the long-term growth rate of
income. Technological progress takes place through a process of capital deepening in the form of the introduction of new varieties of capital goods. MNCs
possess more advanced knowledge, which allows them to introduce new capital
2
Previous research on technology diffusion includes Nelson and Phelps (1966), Jovanovic and Rob
(1989), Grossman and Helpman (1991) (chapters 11 and 12), Segerstrom (1991) and Barro and
Sala-i-Martin (1995) (chapter 8).
3
See Easterly et al. (1994) for a framework incorporating the roles of technology adoption through
international trade and human capital accumulation as determinants of economic growth.!
117
goods at lower cost.4 However, the application of this more advanced technologies
also requires the presence of a sufficient level of human capital in the host
economy. The stock of human capital in the host country, therefore, limits the
absorptive capability of a developing country, as in Nelson and Phelps (1966), and
Benhabib and Spiegel (1994). Hence, the model highlights the roles of both the
introduction of more advanced technology and the requirement of absorptive
capability in the host country as determinants of economic growth, and suggests
the empirical investigation of the complementarity between FDI and human capital
in the process of productivity growth.
We test the effect of FDI on economic growth in a framework of cross-country
regressions utilizing data on FDI flows from industrial countries to 69 developing
countries over the last two decades.5 Our results suggest that FDI is in fact an
important vehicle for the transfer of technology, contributing to growth in larger
measure than domestic investment. Moreover, we find that there is a strong
complementary effect between FDI and human capital, that is, the contribution of
FDI to economic growth is enhanced by its interaction with the level of human
capital in the host country. However, our empirical results imply that FDI is more
productive than domestic investment only when the host country has a minimum
threshold stock of human capital. The results are robust to a number of alternative
specifications, which control for the variables usually identified as the main
determinants of economic growth in cross-country regressions. This sensitivity
analysis along the lines of Levine and Renelt (1992) shows a robust relationship
between economic growth, FDI and human capital.
We also investigate the effect of FDI on domestic investment, namely, whether
there is evidence that the inflow of foreign capital crowds out domestic
investment. In principle, this effect could have either sign: by competing in
product and financial markets MNCs may displace domestic firms; conversely,
FDI may support the expansion of domestic firms by complementarity in
production or by increasing productivity through the spillover of advanced
technology.6 Our results are supportive of a crowding-in effect, that is, a one-dollar
4
It is most likely that a foreign firm that decides to invest in another country enjoys lower costs than
its domestic competitors deriving from higher productive efficiency. The higher efficiency may owe
partly to the combination of foreign advanced management skills with domestic labor and inputs.
Several micro-studies have attempted to assess empirically the impact of FDI on the domestic
economy. (See, for example, United Nations (1992), Aitken and Harrison (1993), and references
therein).
5
De Gregorio (1992) shows, in a panel data of 12 Latin American countries, that FDI is about three
times more efficient than domestic investment. Blomstrom et al. (1992) also find a strong effect of FDI
on economic growth in LDCs.
6
An additional factor could be that policies offering preferential tax treatment and other incentives to
induce inward FDI may introduce a distortion affecting domestic investment. If such distortion between
the return to foreign and domestic capital were significant, it could have a large negative effect on
growth, as in Easterly (1993).
118
increase in the net inflow of FDI is associated with an increase in total investment
in the host economy of more than one dollar, but do not appear to be very robust.
Thus, it appears that the main channel through which FDI contributes to economic
growth is by stimulating technological progress, rather than by increasing total
capital accumulation in the host economy.
The paper is divided into four sections. Section 2 presents a simple model to
motivate our empirical investigation; Section 3 provides an account of the data
used in the empirical analysis; Section 4 describes the regression results, and
Section 5 presents some concluding remarks.
2. An illustrative framework
We consider an economy where technical progress is the result of capital
deepening in the form of an increase in the number of varieties of capital goods
available, as in Romer (1990), Grossman and Helpman (1991) and Barro and
Sala-i-Martin (1995).7 The economy produces a single consumption good according to the following technology:
Yt 5 AH at K t1 a
(1)
K5
5E
x( j)
12 a
dj
1
]]
( 12 a )
(2)
We follow closely the specification of Barro and Sala-i-Martin (1995) (chapter 6).
This formulation is due to Ethier (1982).
(3)
119
We assume that specialized firms produce each variety of capital good, and rent
it out to final goods producers at a rental rate m( j). The demand for each variety of
capital good, x( j), follows from the optimality condition that equates the rental
rate to the marginal productivity of the capital good in the production of the final
good. This condition is:
m( j) 5 A(1 2 a )H a x( j)2 a
(4)
(5)
The importance of the technology gap as a determinant of technological diffusion has been
stressed in previous research, for example, Nelson and Phelps (1966).
120
In addition to the fixed setup cost, once a capital good is introduced, the owner
must spend a constant maintenance cost per period of time. This is analogous to
assume that there is a constant marginal cost of production of x( j) equal to 1, and
that capital goods depreciate fully. Assuming a steady state where the interest rate
(r) is constant, profits for the producer of a new variety of capital j are:
`
(6)
Maximization of Eq. (6) subject to the demand Eq. (4) generates the following
equilibrium level for the production of each capital good x( j):
x( j) 5 HA1 / a (1 2 a )2 / a
(7)
Note that x( j) is independent of time, that is, at every instant the level of
production of each new good is the same. Moreover, the level of production of the
different varieties is also the same due to the symmetry among producers.
Substituting Eq. (7) into the demand function Eq. (4), we obtain the following
expression for the rental rate:
m( j) 5 1 /(1 2 a )
(8)
(9)
where
f 5 a (1 2 a )( 22 a ) / a
To close the model, we need to describe the process of capital accumulation,
which is driven by saving behaviour.10 We assume that individuals maximize the
following standard intertemporal utility function:
`
s
C 12
s
2
Ut 5 ]] e r (s 2t ) ds
12s
(10)
10
Although, for simplicity, we do not introduce international trade in this model, this is not a closed
economy because of the presence of foreign firms. However, with the proportion of foreign firms
remaining constant in a steady-state situation, equilibrium conditions are analogous to those prevailing
in a closed economy.
121
where C denotes units of consumption of the final good Y. Given a rate of return
equal to r, the optimal consumption path is given by the standard condition:
C~
1
]t 5 ](r 2 r )
Ct s
(11)
It is easy to verify that the rate of growth of consumption must, in a steady state
equilibrium, be equal to the rate of growth of output, which we denote by g.
Finally, substituting Eq. (9) into Eq. (11), we obtain the following expression
for the rate of growth of the economy:
1
g 5 ] [A1 / a f F(n * /N, N /N * )21 H 2 r ]
s
(12)
Eq. (12) shows that foreign direct investment, which is measured by the
fraction of products produced by foreign firms in the total number of products
(n * /N), reduces the costs of introducing new varieties of capital goods, thus
increasing the rate at which new capital goods are introduced. The cost of
introducing new capital goods is also smaller for more backward countries; that is,
countries that produce fewer varieties of capital goods than the leading countriescountries with lower N /N * -enjoy lower costs of adoption of technology, and will
tend to grow faster. Furthermore, the effect of FDI on the growth rate of the
economy is positively associated with the level of human capital, that is, the higher
the level of human capital in the host country, the higher the effect of FDI on the
growth rate of the economy.
To assess empirically the effect of FDI on economic growth, we utilize the
following basic formulation:
g 5 c 0 1 c 1 FDI 1 c 2 FDI 3 H 1 c 3 H 1 c 4 Y0 1 c 5 A
(13)
where FDI is foreign direct investment, H the stock of human capital, Y0 initial
GDP per capita, and A is a set of other variables that affect economic growth. The
variable FDI is measured as a ratio to GDP, and is conceptually analogous to the
fraction of goods produced by foreign firms in the model, (n * /N).11 The initial
GDP variable (Y0 ) captures the role of the catch-up effect (N /N * ).12 The group
11
We assume that the average ratio of foreign direct investment to GDP over a decade FDI, which is
a flow variable, is a good proxy for (n * / N). Since FDI measures are available only from 1970, we can
not construct a stock measure of FDI. Also, it is not possible to differentiate between FDI in the capital
goods sector and in other sectors of the economy.
12
The theoretical model described above implies that the catch-up effect can be represented by an
interactive term between initial income and human capital (Y 0* H) in addition to the initial income (Y 0 ).
We find that when both terms are included in the regressions the interactive term (Y *0 H) is not
significant, without much effect on the overall results. However, Benhabib and Spiegel (1994) find an
interactive term in initial income and human capital to be significant for growth in a different
framework.
122
of variables A comprises the control and policy variables that are frequently
included as determinants of growth in cross-country studies. (See Barro and
Sala-i-Martin (1995) (chapter 12)). These variables include government consumption, the black market premium on foreign exchange, a measure of political
instability (political assassinations and wars), a measure of political rights, a proxy
for financial development, the inflation rate, and a measure of quality of
institutions.
3. Data
There are several sources for data on foreign direct investment. Two IMF
publications provide data on net and gross foreign direct investment (International
Financial Statistics, and Balance of Payments Statistics, respectively). Net FDI
refers to inflows net of outflows, and gross FDI refers only to inflows, that is,
foreign direct investment into the country. An OECD publication (Geographical
Distribution of Financial Flows to Developing Countries) tallies gross FDI
originated in OECD member countries into developing economies. The choice
between these alternatives depends on which data set would correspond more
closely to the FDI effect we are trying to uncover.
In the first place, it seems more appropriate to use gross data because we are
interested in the effects of foreign direct investment in the host country via transfer
of knowledge and other spillover effects; in addition, we would not expect the
outflow of foreign direct investment to involve a similar negative growth effects
for the source country (loss of knowledge). In the second place, in our framework,
foreign direct investment flows from industrialized to developing countries to close
the technological gap. Foreign direct investment taking place between countries
with roughly the same level of technological development may respond to a large
extent to other factors, including global firm strategy and market penetration, or to
allow firms to circumvent trade restrictions and offset other advantages accorded
to domestic producers. This type of foreign direct investment flows may not be
expected to display higher than average productivity. For this reason we focus only
on foreign direct investment received by developing countries. And furthermore,
since flows of foreign direct investment between developing countries may also
respond to factors other than the technological gap, we also exclude those flows.
Therefore, the OECD measure of foreign direct investment, while having a partial
coverage, appears to be the most appropriate for our purposes.13 These data are
available on a yearly basis from 1970.
13
Since balance of payments data from Balance of Payments Statistics do not provide information
about the country of origin, it cannot be adjusted to include flows from industrial countries only. There
are, in fact, significant differences between overall gross foreign direct investment in developing
countries and foreign direct investment originated in OECD countries (OECD data). The correlation
between these two measures, although positive, is weak (the correlation coefficient is 0.22).
123
National accounts data, such as the growth rate of income, initial income and
government consumption, are all taken from Summers and Heston (release 5.5 of
June 1993) which provides data up to 1989. This allows us to consider a 20-year
period for the empirical investigation. The growth rate measure is the average
annual rate of per capita real GDP over each decade, 197079 and 198089.
Government consumption is measured by the average share of real government
consumption in real GDP.
For the human capital stock variable we use the initial-year level of average
years of the male secondary schooling constructed by Barro and Lee (1993).
According to Barro and Lee (1994), this measure of educational attainment is the
one most significantly correlated with growth. Data for the other explanatory
variables, such as the domestic investment rate, the foreign exchange parallel
market premium and the measures of political instability and financial development are also taken from Barro and Lee (1994).
4. Results
The purpose of our empirical investigation is to estimate the effects of FDI on
economic growth, and to investigate the channel through which FDI may be
beneficial for growth. In particular, as discussed in Section 2, we examine whether
FDI interacts with the stock of human capital to affect growth rates. We also test
whether the level of FDI has an effect on the overall level of investment in the
country and on the efficiency of investment.
The main regression results indicate that FDI has a positive overall effect on
economic growth, although the magnitude of this effect depends on the stock of
human capital available in the host economy. However, the nature of the
interaction of FDI with human capital is such that for countries with very low
levels of human capital the direct effect of FDI is negative. The cross-country
regressions also show that FDI exerts a positive, though not strong, effect on
domestic investment, presumably because the attraction of complementary activities dominates the displacement of domestic competitors. This is an indirect
effect of FDI on growth, since it operates through pulling in other sources of
investment. All regressions are based on panel data for the two decades 197079
and 198089, and were estimated using the seemingly unrelated regressions
technique (SUR). We do not report cross-section regressions, which basically yield
the same qualitative results as those of the panel estimation. The final sample
consists of 69 developing countries, for which data on all the variables are
available.
Table 1 reveals several interesting results for the effects of FDI on economic
growth. Regression 1.1 shows that FDI has a positive impact on economic growth,
after controlling for initial income, human capital, government consumption and
the parallel market premium for foreign exchange. However, the coefficient of FDI
in this specification is not statistically significant.
124
Table 1
FDI and per capita GDP growth: panel of two decades (197089)
Regression number
Independent
variable
Log (initial GDP)
Schooling
Government
consumption
Log (11black
market premium)
FDI
1.1
1.2
Coefficient
(standard error)
1.3
1.4
1.5
1.6
1.7
20.0124
(0.0040)
0.0162
(0.0044)
20.0969
(0.0339)
20.0183
(0.0055)
0.6590
(0.4689)
20.0122
(0.0039)
0.0128
(0.0045)
20.0811
(0.0333)
20.0185
(0.0054)
20.8489
(0.7203)
1.6231
(0.6086)
20.0100
(0.0041)
0.0078
(0.0044)
20.0818
(0.0326)
20.0188
(0.0060)
21.0190
(0.6883)
1.3891
(0.5715)
20.0188
(0.0060)
20.0202
(0.0057)
20.0125
(0.0041)
0.0058
(0.0043)
20.0817
(0.0323)
20.0125
(0.0052)
21.3665
(0.6746)
1.6639
(0.5743)
20.0200
(0.0060)
20.0221
(0.0058)
20.0024
(0.0124)
20.0077
(0.0050)
20.0032
(0.0014)
0.0061
(0.0044)
0.0033
(0.0042)
20.0668
(0.0323)
20.0104
(0.0054)
21.4628
(0.6612)
1.6531
(0.5930)
20.0197
(0.0064)
20.0219
(0.0067)
20.0092
(0.0128)
20.0024
(0.0057)
20.0023
(0.0014)
0.0011
(0.0117)
20.0119
(0.0090)
20.0111
(0.0050)
0.0005
(0.0005)
20.0435
(0.0316)
20.0113
(0.0054)
21.8535
(0.6759)
1.6365
(0.6365)
20.0253
(0.0068)
20.0155
(0.0070)
20.0050
(0.0129)
20.0002
(0.0057)
20.0001
(0.0014)
0.0031
(0.0117)
20.0087
(0.0092)
0.0056
(0.0019)
0.39(58)
0.15(60)
1.13
(22)
FDI*schooling
20.0126
(0.0043)
0.0142
(0.0043)
20.0870
(0.0330)
20.0180
(0.0054)
1.0659
(0.3850)
Sub-Saharan
African dummy
Latin American
dummy
Assassinations
Wars
Political rights
(1 best, 7 worst)
Financial
depth
Inflation
rate
Institutions
(1 worst, 10 best)
R 2 -adjusted, individual
periods (No. of obs.)
Education threshold
(No. countries.threshold)
0.28(69)
0.08(69)
0.32(69)
0.10(69)
0.33(69)
0.08(69)
0.52
(46)
0.34(69)
0.23(69)
0.73
(38)
0.37(69)
0.19(69)
0.82
(32)
0.32(64)
0.21(67)
0.89
(29)
Notes: The system has 2 equations, where the dependent variables are the per capita GDP growth rates over each decade. Each equation
has a different constant term (not reported)b . Other coefficients are constrained to be the same for all periods. Estimation is by the SUR
technique. The estimation allows for different error variances in each equation and for correlation of these errors across equations.
Education threshold indicates that countries with secondary schooling above this threshold will benefit positively from FDI. The number
of countries that satisfy it in 1980 for each regression is in the parenthesis.
Including the interaction between FDI and human capital improves the overall
performance of the regression. The specification in regression 1.2 replaces the FDI
variable by the product between FDI and human capital, and yields a coefficient
that is positive and highly statistically significant. While this specification follows
125
14
Meaning a male population above 25 years with an average of 0.52 years of secondary schooling.
An example of an economy with secondary school attainment of 0.52 is the following: only 10 percent
of the population above 25 years of age has ever attended secondary school; out of this group, only 75
percent completed secondary school (6 years), with the remaining going only through the first cycle (3
years). Then, secondary school attainment is 0.103[330.251630.75]10.93050.53.
15
We have also included the average level of tariffs as one of the regressors, but it was not
significantly different from zero.
126
16
One reason why the measures of political instability, financial development and inflation rates are
insignificant in the regressions may be that the sample used in our regressions includes only developing
countries.
17
The estimation of a general nonlinear functional form is not a promising prospect, however. This
would require to add higher order terms not only for the variables (such as FDI squared and schooling
squared) but also for the interaction terms (such as FDI times schooling squared, etc.). This would not
only reduce the degrees of freedom in the estimation but also probably cause significant multicollinearity problems.
127
128
technological advances, FDI has probably an even larger role, as it also allows the
transmission of knowledge on business practices, management techniques, etc.
This would be the case, for example, if FDI stimulated investment in activities that are
complementary to the projects undertaken by the foreign firms.
129
Table 2
FDI and aggregate investment rates: panel of two decades (197089)
Regression number
Independent
variable
Log(initial GDP)
Schooling
Government
consumption
Log(11black
market premium)
FDI
2.1
2.2
Coefficient
(standard error)
2.3
2.4
2.5
2.6
0.0346
(0.0102)
0.0197
(0.0109)
20.1217
(0.0876)
20.0078
(0.0118)
2.2944
(0.9919)
0.0356
(0.0105)
0.0045
(0.0105)
20.1367
(0.0843)
20.0071
(0.0105)
1.5257
(0.9367)
0.0361
(0.0108)
0.0042
(0.0106)
20.1276
(0.0869)
20.0072
(0.0010)
1.5477
(0.9456)
0.0324
(0.0115)
0.0007
(0.0106)
20.1256
(0.0902)
20.0129
(0.0116)
1.2641
(0.9367)
0.0291
(0.0128)
0.0043
(0.0114)
20.1224
(0.0905)
20.0083
(0.01155)
0.7833
(0.9442)
20.0647
(0.0172)
20.0647
(0.0158)
20.0653
(0.0177)
20.0626
(0.0166)
20.0103
(0.0229)
0.0027
(0.0102)
0.0006
(0.0033)
20.0454
(0.0181)
20.0426
(0.0185)
20.0228
(0.0226)
0.0160
(0.0103)
20.0016
(0.0033)
0.0252
(0.0249)
20.0364
(0.00151)
20.0449
(0.0197)
20.0332
(0.0186)
20.0186
(0.0222)
0.0166
(0.0102)
20.0006
(0.0034)
0.0148
(0.0248)
20.0389
(0.0151)
0.0111
(0.0055)
0.17(58)
0.55(60)
FDI*schooling
0.0344
(0.0101)
0.0210
(0.0113)
20.1283
(0.0887)
20.0080
(0.0117)
2.8230
(1.6257)
20.5165
(1.2926)
Sub-Saharan
African dummy
Latin American
dummy
Assassinations
Wars
Political rights
(1 best, 7 worst)
Financial
depth
Inflation
rate
Institutions
(1 worst, 10 best)
R 2 -adj, individual
periods (No. of obs.)
0.23(69)
0.44(69)
0.22(69)
0.43(69)
0.26(69)
0.55(69)
0.21(69)
0.53(69)
0.17(64)
0.51(67)
Notes: The system has 2 equations, where the dependent variables are the average ratios of investment
to GDP over each decade. See note to Table 1.
are higher compared to those reported in Table 1. In the basic regression 3.3, the
values of the coefficients (21.461 for FDI and 1.647 for the interaction term)
imply that the threshold level of education for which the effects of FDI turn
positive is 0.88, which is satisfied by 29 countries in the sample. Note, however,
that countries with school attainment below 0.88 would still benefit from FDI if
the crowding-in effect on domestic investment were significant. For example,
taking a value of 1.5 for the crowding-in coefficient-close to the average of the
point estimates in Table 3-and using the parameter values estimated in regression
130
Table 3
Per capita GDP growth: productivity of FDI and domestic investment
Regression number
Independent
variable
Investment rate
Log (initial GDP)
Schooling
Government
consumption
Log(11black
market premium)
FDI
3.1
3.2
Coefficient
(standard error)
3.3
3.4
3.5
3.6
3.7
3.8
0.1403
(0.0320)
20.0167
(0.0038)
0.0133
(0.0041)
20.0840
(0.0306)
20.0169
(0.0051)
0.0605
(0.4535)
0.1415
(0.0307)
20.0165
(0.0036)
0.0098
(0.0041)
20.0663
(0.0299)
20.0165
(0.0049)
21.4607
(0.6728)
1.6473
(0.5555)
0.1422
(0.0425)
20.0165
(0.0037)
0.0100
(0.0087)
20.0664
(0.0300)
20.0166
(0.0050)
21.4639
(0.6796)
1.6520
(0.5818)
20.0010
(0.0411)
0.1120
(0.0317)
20.0137
(0.0040)
0.0069
(0.0040)
20.0711
(0.0303)
20.0155
(0.0047)
21.4928
(0.6581)
1.4953
(0.5415)
0.1028
(0.0311)
20.0157
(0.0040)
0.0052
(0.0040)
20.0719
(0.0305)
20.0120
(0.0050)
21.7599
(0.6496)
1.7197
(0.5476)
0.0923
(0.0304)
20.0090
(0.0043)
20.0031
(0.0039)
20.0612
(0.0304)
20.0098
(0.0052)
21.7933
(0.6398)
1.7101
(0.5665)
0.0880
(0.0323)
20.0120
(0.0048)
20.0013
(0.0048)
20.0375
(0.0299)
20.0100
(0.0051)
22.2058
(0.6645)
1.8858
(0.6132)
20.0124
(0.0058)
20.0142
(0.0055)
20.0166
(0.0057)
20.0199
(0.0062)
20.0022
(0.0120)
20.0067
(0.0049)
20.0028
(0.0013)
20.0154
(0.0062)
20.0186
(0.0064)
20.0071
(0.0124)
20.0025
(0.0055)
20.0020
(0.0013)
20.0041
(0.0112)
20.0098
(0.0087)
20.0218
(0.0065)
20.0154
(0.0066)
20.0039
(0.0124)
0.0002
(0.0056)
20.0002
(0.0014)
20.0020
(0.0113)
20.0067
(0.0089)
0.0042
(0.0019)
0.40(58)
0.19(60)
1.10
(23)
FDI*schooling
0.1279
(0.0309)
20.0169
(0.0037)
0.0124
(0.0040)
20.0781
(0.0301)
20.0160
(0.0050)
0.7324
(0.3658)
Investment rate*
schooling
Sub-Saharan
African dummy
Latin American
dummy
Assassinations
Wars
Political rights
(1 best, 7 worst)
Financial
depth
Inflation
rate
Institutions
(1 worst, 10 best)
R2-adj, individual
periods (no. of obs.)
Education threshold
(No. countries.threshold)
0.41(69)
0.13(69)
0.41(69)
0.17(69)
0.44(69)
0.16(69)
0.76
(36)
0.43(69)
0.15(69)
0.76
(36)
0.43(69)
0.23(69)
0.88
(29)
0.44(69)
0.20(69)
0.93
(29)
0.38(64)
0.22(67)
0.97
(29)
3.3, the threshold value of human capital becomes 0.76 years of post-primary
education, which is satisfied by 36 countries in the sample.
In order to investigate whether the interaction effect is unique to foreign
investment, or it applies to investment from all sources, we have also added an
131
We also tested the robustness of the results to the effect of possibly influential observations in the
form of those countries that have received the highest levels of FDI. The results (available from the
authors) of regressions excluding the seven countries which received the highest levels of FDI over the
sample period are very similar to those obtained for the whole sample, with threshold levels of human
capital increasing only marginally.
20
See Edwards (1990) for a discussion on the determination of foreign direct investment in LDCs.
132
Table 4
FDI and per capita growth: instrumental variables estimation
Regression number
Independent
variable
4.1
4.2
Estimation method
4.3
4.4
4.5
4.6
4.7
4.8
4.9
3SLS
3SLS
Coefficient
(standard error)
3SLS
3SLS
3SLS
3SLS
3SLS
2SLS
2SLS
20.0115
(0.0042)
0.0055
(0.0044)
20.0848
(0.0326)
20.0127
(0.0052)
21.7086
(0.8001)
1.5522
(0.6344)
20.0206
(0.0060)
20.0240
(0.0060)
0.1094
(0.0315)
20.0150
(0.0040)
0.0051
(0.0040)
20.0743
(0.0306)
20.0122
(0.0050)
22.0461
(0.7649)
1.6031
(0.6043)
20.0142
(0.0058)
20.0177
(0.0058)
20.0106
(0.0050)
20.0007
(0.0052)
20.0416
(0.0319)
20.0111
(0.0054)
22.4322
(0.7902)
1.7039
(0.7092)
20.0256
(0.0069)
20.0164
(0.0070)
0.0934
(0.0329)
20.0116
(0.0048)
20.0025
(0.0050)
20.0346
(0.0305)
20.0094
(0.0051)
22.6497
(0.7680)
2.0154
(0.6880)
20.0217
(0.0066)
20.0164
(0.0067)
0.0791
(0.0576)
20.0084
(0.0058)
20.0023
(0.0074)
20.0224
(0.0483)
20.0046
(0.0056)
21.8619
(1.7948)
1.8156
(1.1105)
20.0074
(0.0083)
20.0305
(0.0081)
0.1493
(0.0697)
20.0032
(0.0072)
20.0104
(0.0083)
0.0450
(0.0551)
0.0011
(0.0063)
24.1850
(1.8170)
3.5432
(1.2132)
20.0140
(0.0102)
20.0298
(0.0096)
20.0039
(0.0123)
20.0006
(0.0056)
20.0002
(0.0014)
20.0015
(0.0117)
20.0062
(0.0088)
0.0045
(0.0019)
0.38(58)
0.20(60)
1.24
(15)
0.0054
0.0130
(0.0127) (0.0145)
0.0108
0.0166
(0.0063) (0.0074)
20.0047 20.0027
(0.0018) (0.0020)
20.0188
(0.0170)
20.0110
(0.0098)
0.0022
(0.0031)
0.38(69) 0.36(60)
Investment rate
Log(initial GDP)
Schooling
Government
consumption
Log(11black
market premium)
FDI
FDI*schooling
Sub-Saharan
African dummy
Latin American
dummy
Investment*
schooling
Assassinations
20.0092
(0.0042)
0.0071
(0.0045)
20.0814
(0.0329)
20.0166
(0.0050)
21.4575
(0.8253)
1.4791
(0.6314)
20.0191
(0.0060)
20.0214
(0.0058)
0.1177
(0.0324)
20.0133
(0.0040)
0.0064
(0.0041)
20.0705
(0.0305)
20.0156
(0.0047)
21.8272
(0.7875)
1.5307
(0.5972)
20.0122
(0.0058)
20.0150
(0.0055)
Wars
Political rights
(1 best, 7 worst)
Financial
depth
Inflation
rate
Institutions
(1 worst, 10 best)
R 2 -adj, individual
periods (no. of obs.)
Education threshold
(No. countries.threshold)
0.34(69)
0.22(69)
0.99
(28)
0.43(69)
0.23(69)
1.08
(26)
0.1237
(0.0421)
20.0138
(0.0040)
0.0099
(0.0085)
20.0707
(0.0302)
20.0159
(0.0047)
21.5369
(0.6625)
1.5589
(0.5598)
20.0124
(0.0058)
20.0146
(0.0056)
20.0166
(0.0403)
0.96
(29)
1.12
(23)
Note: three-stage least squares (3SLS) estimation was done on a system of two equations for the periods 197079 and 198089, using as
instruments: the lagged value of FDI, the log value of total GDP, the log value of area, and continental dummies for East Asia and South
Asia. The two-stage least squares (2SLS) estimation was done on the cross-section of countries for the period 198089 using the same
instruments.
133
5. Conclusions
There is a good a priori case to presume that FDI is more productive than
domestic investment. As Graham and Krugman (1991) argue, domestic firms have
better knowledge and access to domestic markets; if a foreign firm decides to enter
the market, it must compensate for the advantages enjoyed by domestic firms. It is
most likely that a foreign firm that decides to invest in another country enjoys
lower costs and higher productive efficiency than its domestic competitors. In the
case of developing countries in particular, it is likely that the higher efficiency of
FDI would result from a combination of advanced management skills and more
modern technology; FDI may be the main channel through which advanced
technology is transferred to developing countries.
Different types of economic distortions, however, may jeopardize the role of
FDI as a means for advanced technology transfer. For example, because of
protectionist trade policies, FDI may be the only way to gain access to domestic
21
Because the data on FDI are available only from 1970, we have used the initial value of FDI over
the period 197072 as an instrument for the first decade. For the second decade, the lagged value of
FDI over the period 197580 was used as an instrument. The rationale for the inclusion of total GDP
and country area as instruments is that they represent the effect of market size and of the abundance of
natural resources, respectively, which have been often mentioned as important determinants of FDI in
previous literature.
134
markets by firms that would otherwise have been exporters to the host country.
Similarly, governments may offer a set of incentives to foreign investors to
stimulate the inflow of FDI, with the objective of increasing foreign exchange
reserves or of developing certain sectors considered strategic from an industrial
policy viewpoint. These policies may result in a flow of FDI that does not respond
to higher efficiency but only to profit opportunities created by distorted incentives.
These considerations make the empirical evaluation of the performance of FDI an
appealing question. We investigated these issues in a sample that comprises FDI
flows from industrial country into developing countries
The most robust finding of this paper is that the effect of FDI on economic
growth is dependent on the level of human capital available in the host economy.
There is a strong positive interaction between FDI and the level of educational
attainment (our proxy for human capital). Notably, the same interaction is not
significant in the case of domestic investment, possibly a reflection of differences
of technological nature between FDI and domestic investment. We also found
some evidence of a crowding-in effect, namely that FDI is complementary to
domestic investment. This effect, however, seems to be less robust than our other
findings.
Some caution must be exercised, however, in the interpretation of the size of the
effect on economic growth of FDI. Our data measures the international flow of
resources for foreign direct investment, as recorded in balance of payments
statistics. This is, however, only part of the resources invested by a multinational
firm, because some part of the investment may be financed through debt or equity
issues raised in the domestic market. Thus, our measure of FDI underestimates the
total value of fixed investment made by a multinational firm and the coefficients
on FDI may be proportionally overestimated. To the extent that this bias in the
measure of FDI is uniform across countries and over time, the qualitative results
are not affected.
Finally, the results of this paper suggest some directions for further research.
The results suggest that the beneficial effects on growth of FDI come through
higher efficiency rather than simply from higher capital accumulation. This
suggests the possibility of testing the effect of FDI on the rate of total factor
productivity growth in recipient countries. In addition, given the robustness of the
effect of interactions between human capital and FDI, it might be interesting to
explore the effects of FDI on the level of human capital. As we have argued
above, FDI is a vehicle for the adoption of new technologies, and therefore, the
training required to prepare the labour force to work with new technologies
suggests that there may also be an effect of FDI on human capital accumulation.
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